Regulation & Governance (2008) 2, 360–380
doi:10.1111/j.1748-5991.2008.00039.x
RESEARCH FORUM
An overview: A new era of tax
enforcement – from ‘‘big stick’’ to
responsive regulation
Sagit Leviner
Internal Revenue Service National Headquarters, Office of Chief Counsel=Office of Research,
US Department of the Treasury, Washington, DC, USA
Abstract
Recent developments in regulation and tax administration in Australia inspired this article on
tax compliance and responsive regulation. This article analyzes the economics of crime and
compliance as the dominant approach to tax enforcement of the past three and a half decades.
It evaluates the key advantages and disadvantages of the economic approach as well as its
application to tax. The article then explores responsive regulation as an alternative method that
draws on the economic paradigm but also supplements this approach with other theories, particularly those involving identity, conflict escalation, and procedural justice. Building on this
analysis and a case study of Australian investors in mass marketed tax schemes, the article suggests that the broader, more balanced, and closely tailored method of regulating responsively
may enable regulators to draw on the advantages of the economic model while alleviating some
of its drawbacks. Responsive regulation may therefore constitute a superior method for regulating compliance.
Keywords: responsive regulation, law enforcement and correction, tax compliance, tax administration, comparative law, law and society, law reform, economic analysis.
Introduction
Preserving the integrity of the tax system has challenged societies throughout history.
Tax noncompliance is a serious problem that fosters a climate of disrespect, antagonism,
and selfishness in the relationships among citizens and between them and the government and distorts the distribution of the tax burden and wealth in society (Carroll 1989;
Cowell 1990; Slemrod 1992; Kaplow 1996). Despite evident benefits of increasing tax
compliance, the complexity of the Tax Code, the magnitude and persistent levels of
noncompliance, and democratic principles that restrain government interference with
the conduct of civilians mandate that no tax system achieves perfect compliance. Still,
due to the size of the tax gap (the difference between those taxes that are legally owed and
those that are punctually and accurately paid), even a small or moderate reduction in
existing noncompliance can yield substantial returns. According to a 2004 Government
Correspondence: Sagit Leviner, 500 N, Capitol Street NW, Washington DC 20001-1531, USA.
Email: [email protected]
Accepted for publication 26 May 2008
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S. Leviner
Accountability Office (GAO) report, each 1% reduction in the US net tax gap is likely
to yield more than $US2.5 billion annually (GAO 2004). Thus, a 10–20% reduction
could add $US25 billion to $US50 billion or more in revenue annually; no small change
by any account.
Like other tax administrations in the industrialized world, over the years the Internal
Revenue Service (IRS) has taken a number of steps to ease the tax gap including substantially enhancing enforcement efforts and resources (IRS 2004, 2006). Unfortunately,
despite some increases in enforcement revenue,1 the net difference between taxes owed
and taxes collected in the US remains close to $300 billion per tax year. This raises the
question whether the steps taken thus far are sufficient to alleviate the problem of tax
noncompliance. If not sufficient, what alternatives are available to government agencies
and other regulatory institutions?
This article explores one alternative solution to the problem of noncompliance.
It suggests that expansion of the traditional tax compliance analysis to include responsive
elements of regulation, as illustrated in the Australian Tax Office’s (ATO) approach to
tax enforcement, may yield a more useful and forward-looking approach to tax compliance and enforcement than those available under other systems. The responsive regulation approach is based on the proposition that effective enforcement requires
a dynamic and gradual application of less to more severe sanctions and regulatory
interventions (Braithwaite 1985). This range of sanctions and interventions balances
traditional authoritarian deterrence with strategies that rely on persuasion and encouragement through three states of communication – cooperation, toughness, and forgiveness (Ayres & Braithwaite 1992). The Australian approach also advocates a deeper
understanding of the motives, circumstances, and characteristics of taxpayers, so tax
authorities can tailor enforcement to effectively deliver compliance (ATO 1997, 1998).
With responsive regulation, the intent is to preserve the basic principles of economic
analysis that view taxpayers as rational actors seeking to maximize their expected utility.
Responsive regulation goes a step further, however, and also considers other parameters,
including the way society, morality, and ethics affect taxpaying behavior and, particularly, the manner in which the taxpayer–tax administration relationship shapes
compliance.
Section 1 of this article reviews the economic model as the origin of the analysis of
compliance with the law and discusses the application of this model to the realm of
taxation. Section 2 explores key advantages and disadvantages of the economic approach
to tax enforcement, concluding that the economic model is persuasive in many respects
but flawed in others. In Section 3, this article introduces the Australian approach to tax
enforcement as a method that draws heavily on the economics of the crime model yet
moves beyond the economic realm to rely on other complementary theories. This section
of the article advances the argument that, as a result of this broader perspective, the
Australian approach has the potential to capture the strengths of the economic paradigm
while also addressing some of its drawbacks. Section 4 illustrates the supremacy of
regulating responsively with a case study involving tax schemes mass marketed to Australian taxpayers in the late 1990s. Section 5 summarizes and concludes the article,
suggesting that the Australian method of regulating responsively may mark the beginning of a new era of tax enforcement. The main focus of this article is personal income
tax compliance although much of the discussion provides important insights into other
regulatory areas.
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1. Economic analysis and tax enforcement: From Becker’s approach to
law enforcement to the deterrence hypothesis and its application to
tax compliance
Over the past four decades, economic analysis has played a pivotal role in crystallizing the
issue of individual and organizational compliance with legal obligations. Particularly, in
a regulatory environment such as taxation, where many of the relevant variables are often
unobservable and complex, economic models become highly instrumental in simplifying
the relationships at hand to produce a coherent framework. Economic modeling of tax
compliance has also facilitated an important process in policymaking by enabling the
assessment and comparison of the consequences of different enforcement strategies.
This, in turn, stimulates the formation of well-informed debates over alternative policies
(Creedy 2001).
The principal model for analysing issues of compliance with the law derives from the
classic work in utilitarianism of Jeremy Bentham and Cesare Beccaria who laid the foundation for a framework of economic analysis that tells a relatively straightforward and
realistic story of human behavior (Bentham 1788; Beccaria 1797). The basic premise of the
utilitarian theory is that people behave rationally to maximize their expected utility. In the
context of compliance, the assumption is that, facing a feasible set of courses of action,
some of which are legal while others are not, individuals choose whether to commit a crime
or not based on which option has the better prospect of increasing their utility. The
economic approach to compliance, although influential at the time of its conception,
received very little attention from later theorists and policymakers until Gary Becker
modernized it in his groundbreaking article ‘‘Crime and Punishment’’ (Becker 1968).
Instead of adhering to theories of mental illness and social oppression that dominated discussions of crime during his time, Becker’s analysis returned to the utilitarian
premise of Bentham and Beccaria and explored the possibility that criminal behavior is
in fact rational. In Becker’s words: ‘‘[A] person commits an offense if the expected utility
to him exceeds the utility he could get by using his time and other resources at other
activities. Some persons become ‘criminals,’ therefore, not because their basic motivations differ from that of other persons, but because their benefits and costs [resulting
from compliance and noncompliance with the law] differ’’ (Becker 1968, p. 176; see also
Becker 1993). Focusing on these costs and benefits, the ‘‘deterrence hypothesis’’ emerged
suggesting that, if individuals are rational decision-makers whose aim is to maximize
expected utility, the way for the authorities to further compliance with the law is to deter
individuals from acts of noncompliance by ensuring that the expected utility from noncompliance is lower (i.e. less beneficial) than the expected utility from compliance. In
this context, Becker’s analysis advanced the argument that public resources ought to be
allocated to policy measures of two kinds – one aimed at detecting noncompliers and the
other designed to sanction identified offenders. Under Becker’s doctrine, finding the
optimal balance between these two measures becomes the key factor in deterring potential
offenders and making compliance the rational choice of behavior (Becker 1968, p. 208).
Compared with the general economic theory of crime, its tax counterpart is a relatively recent development, dating back about 35 years, particularly, to the much cited
article, ‘‘Income Tax Evasion: A Theoretical Analysis,’’ by Michael Allingham and Agnar
Sandmo (Allingham & Sandmo 1972). Allingham and Sandmo extended Becker’s work
on the economics of crime to taxation using modern risk theory. Similar to Becker, they
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built their analysis around the utility maximizing individual, this time the taxpayer, who
becomes the potential criminal. Allingham and Sandmo’s model presents the issue of
compliance as a portfolio allocation problem in which the taxpayer must decide what
portion of her income to allocate to various activities, some of which result in income
legally declared while others result in income illegally shirked (Allingham & Sandmo
1972, p. 323). Their analysis leads to unambiguous results when it comes to the relationship between the taxpayer’s penalty rate, the probability of detection, and tax evasion (cf.
Yitzhaki 1974). Allingham and Sandmo confirm Becker’s findings that a higher penalty
rate and probability of detection tend to discourage tax evasion. While the expected tax
yield falls with a decrease in the probability of detection, an increase in the penalty rate
can compensate for the loss of revenue, such that the two enforcement alternatives
emerge as substitutes for one another (Allingham & Sandmo 1972, p. 330).
1.1. An expanded view of taxpaying behavior
While the economic model of compliance provides an intuitively appealing description
of the tax evasion phenomenon, real-world tax compliance behavior as well as enforcement mechanisms are much more complex than this analysis suggests. Research efforts
designed to add depth and realism to the study of tax compliance resulted in the
Allingham–Sandmo framework being the subject of extensive research. These research
efforts included, among others, attempts to endogenize critical parameters involved in
tax compliance, such as accounting for randomness in the audit rate and in the taxpayer’s true tax liability (e.g. Reinganum & Wilde 1985; Graetz et al. 1986; Reinganum &
Wilde 1986) and incorporating additional and more diverse variables, including elements of memory and time (e.g. Engel & Hines 1999) as well as labor market variables
(e.g. Cowell 1981). Although the traditional economic analysis of tax compliance has
been expanded to include these and other more detailed explanatory variables, its focus
on only two key enforcement parameters, punishment and detection, remains unsatisfactory and not on a par with real-world enforcement practices or needs. Further, the
underlying assumption of the economics of compliance – that every person is engaged
in some type of rational calculation where she will conceal income as long as the return
on noncompliance is positive – does not reflect existing findings on taxpaying behavior
(Graetz & Wilde 1985; Skinner & Slemrod 1985; Smith & Kinsey 1987). According to
survey information, most taxpayers consider themselves to be honest in their tax reporting, and presumably they are, if the available tax compliance rates are accurate (Wenzel
2001).2 In fact, tax compliance literature has repeatedly suggested that ‘‘given the current
mild sanctions and low probability of detection . [one] would predict that virtually
everyone should be evading tax.’’ In other words, instead of asking ‘‘Why do people
evade taxes?’’ we should be asking ‘‘Why do people pay them?’’ (Hessing et al. 1992,
p. 292 (citations omitted); cf. Lederman 2007).
2. A closer look at enforcement strategies: Deterrence and beyond
Empirical and experimental studies tend to support the economic model of compliance
to the extent that they generally identify a negative relationship between the probability
and severity of punishment and the rate of crime (Andreoni et al. 1998; Eide 2000;
Slemrod & Yitzhaki 2002). This effect has also been detected in the area of tax compliance (Friedland et al. 1978; Clotfelter 1983; Witte & Woodbury 1985; Beck et al. 1991).3
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A closer look at the data reveals, however, that an increase in the severity of punishment
may not have the same effect on compliance as a rise in the probability of detection (e.g.
Becker 1968, p. 176; Kahan 1997, p. 380). In either case, enforcement efforts relying solely
on punitive strategies may ultimately fall short of addressing effectively the problem of
noncompliance and might even worsen the situation.4
Specifically, evidence on tax enforcement generally confirms the conclusion that
taxpayers are highly responsive to the perceived or actual risk of detection. According
to IRS estimates, compliance is most likely where the risk of detection is significant, such
as when third-party reporting or withholding takes place. Taxpayers misreport a mere
1% of all wage, salary, and tip income contributing approximately $10 billion to the US
tax gap (IRS 2006). In contrast, non-farm sole proprietor income, which is subject to
little third-party reporting or withholding, has a significantly higher rate of misreporting
of approximately 57%, which contributes about $68 billion to the tax gap (IRS 2006).
In terms of the punishment parameter, fines and other types of penalties also tend to
improve compliance. When it comes to real-life behavior, however, small changes in
penalties are easily overlooked and unlikely to affect compliance (Cheng 2006). Some
researchers go so far as to suggest that heavy penalties do not always produce more
compliance than lighter ones, especially when detection probability is high (Friedland
1982). In certain studies, the effect of an increase in the severity of punishment is not
statistically significant, and a statistically significant positive effect on criminal behavior
is also occasionally identified (Eide 2000, pp. 359–360). Ultimately, in most cases penalties serve as less of a deterrent for committing crimes than the probability of detection
because the effect of deterrence decreases rapidly, and nonlinearly, with lower probabilities of enforcement, and tougher punishments are often unable to offset these losses
(Cheng 2006, p. 659).
Despite the heightened deterrent effect of detection compared with punishment,
on the assumption of a fixed enforcement budget, efforts to maximize deterrence and
revenue at minimal cost might lead policymakers to favor extreme yet rare punishments
(Becker 1968, pp. 180–181). Unfortunately, however, even if effective in improving
compliance, an enforcement strategy of extreme and rare penalties may be a poor strategic choice because of the repercussions it is likely to have outside of its immediate
ability to coerce compliance. In particular, rare and extreme punishments can provoke
community outrage. The idea that the government doles out just punishment is undermined when it disproportionately sanctions offenders (Sandmo 2005, p. 660). When it
comes to serious crimes, inflicting heavy penalties on a rare few is also arbitrary, draconic, and highly discriminatory (Cheng 2006, p. 659). Such an approach might even
lead to underenforcement as tax administrators become conflicted between their legal
obligations and moral judgments (cf. Kahan 2000, p. 608). Imposing rare but severe
sanctions may also lead to an increase in the severity of crimes committed as offenders
realize that sanctions will be extreme regardless of the actual offence committed and
attempt to ‘‘maximize’’ their gain from crime (Cowell 2004, pp. 249–250).
Indeed, taking any form of punitive enforcement to an extreme threatens the democratic nature of society and carries a risk of inflaming a broader conflict between citizens
and the government. Such an approach to tax enforcement might backfire because of
what Bruno Frey describes as a ‘‘crowding out effect’’ of the intrinsic motivations individuals have to comply with their legal obligations, setting the tone for a taxpayer–
tax authority relationship that is dominated by feelings of antagonism and distrust
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(Frey 1997a, b). This type of interaction ultimately diminishes taxpayers’ willingness to
comply voluntarily with their tax obligations and might also lead them to actively resist
paying their taxes, either legally or illegally (Kagan & Scholz 1984; Lind & Tyler 1988;
Tyler 1990b; Feld & Frey 2002; Frey & Fled 2002; Feld & Frey 2006). Authoritarian
enforcement presents additional pitfalls by increasing the visibility of noncompliance
and, by doing so, not only conveying to taxpayers what is legally forbidden but also
coaching them on what they can get away with (Kinsey 1986; Carroll 1989).
From an economic perspective, even when increased enforcement is feasible, conducive to democracy, and results in greater compliance, raising these efforts to the
maximum might still be suboptimal. Enforcement expenditures constitute a real cost
to the economy while the revenue collected can be viewed as a mere transfer from the
private to the public sector (Slemrod 1992, pp. 1–2). Further, increased enforcement of
the tax system might also have disincentive effects similar to an increase in the tax rate or
broadening the tax base and should therefore be undertaken with caution and restraint
(Franzoni 2000, p. 62).
In addition to the considerations that counsel against extreme enforcement, empirical evidence suggests that even moderate means of enforcement may fail to effectively
promote compliance. When researchers tested the rate and probability of punishment at
moderate (compared with extreme) levels, consistent with actual tax enforcement practices, they found the deterrent effects to be quite small (Alm et al. 1992a). Further,
enforcement efforts that rely exclusively on punitive measures and the severity and
probability of punishment are likely to be short-sighted at best and counterproductive
at worst. Taxpayers adapt, take up new strategies, and become increasingly sophisticated
in their risk assessment of being caught and penalized.5 In an area as complex and
controversial as tax, legalistic and authoritarian attempts at shaping behavior are
expected to lead to a never-ending process, as efforts to address one type of undesirable
behavior leave countless others unattended (McBarnet 2003).
A broader, more constructive approach to deterrence than the one adopted under the
traditional economic analysis must reach beyond the use of threat and legal authority to
include other factors and mechanisms that will offer complementary means to combat
crime. This more holistic method is a familiar practice in regulatory programs generally
and it would seek to improve tax compliance not only by curbing illegal activity but also
by encouraging legal behavior, including through balancing authoritarian deterrence
with positive encouragement and assistance. Such a balanced approach is particularly
appropriate in taxation where compliance can be difficult and not always in the shortterm self-interest of the regulated, and where the very classification and detection of
noncompliance might become challenging as well (Smith 1992).6
2.2. The multiplicity of taxpaying behavior
The traditional economic literature on tax compliance examines taxpaying behavior
through the decisions of a single individual. As evident in Becker’s early essay and
continuing with the work of Allingham and Sandmo, the analysis has focused on the
individual taxpayer and her choice of whether or not, and to what extent, she complies
with her legal obligations. Set in this way, the economic paradigm fails to put the issue of
tax compliance in its broader context and, consequently, misses important explanatory
opportunities. One example of this oversight is the limited range of goods examined in
the standard analysis, which tends to portray individuals as concerned only with their
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private consumption while displaying total disregard for public goods and services
(Cowell 2004). Evidence, however, demonstrates that taxpayers expect to receive certain
returns on the taxes they pay (Alm et al. 1992b). Not only do taxpayers care about these
returns but they also evaluate whether the tradeoff is equitable compared to what other
taxpayers appear to receive (Spicer & Becker 1980; cf. Frank 1985). Moreover, one study
that compared the effect of various information sources on taxpaying behavior found
that social influence plays a key role. Specifically, the study demonstrated that information taxpayers receive about the compliance of those with whom they discuss taxes have
the strongest effect on these taxpayers’ commitment to comply with their tax obligations
(Scholz et al. 1992). When taxpayers believed people around them tend to cheat, they
were more likely to cheat themselves, and when taxpayers believed others are generally
honest, they were more willing to pay their own taxes honestly.
It becomes clear, therefore, that taxpaying behavior is not merely the result of isolated calculations of the monetary costs and benefits taxpayers expect to incur from
compliance and noncompliance. Taxpaying behavior is also a social process where
taxpayers share information, experiences, attitudes, and patterns of behavior that affect
their assessments of costs and benefits and, consequently, their actual compliance with
the tax law (e.g. Schwartz & Orleans 1967; Roth & Scholz 1989; Carroll 1992; Lederman
2003a,b; Kirchler 2007; Torgler 2007). One may even go so far as to argue that moral,
ethical, and social factors play a more important role in compliance than the threat of
legal punishment (Scholz et al. 1992; Steenbergen et al. 1992; Kahan 2001). For example,
Grasmick and Scott (1982) find that, while the relationship between the threat of legal
punishment and intention to evade taxes is statistically significant, anticipated feelings of
guilt and social stigma attached to tax evasion are more strongly associated with deterrence.
Similarly, Mason and Mason (1992) argue that an appeal to taxpayer conscience or civic
virtue can improve tax compliance more than the threat of legal sanctions. Other scholars clarify that detection and punishment could be complementary strategies to moral,
ethical, and social appeals, especially when applied to different groups of taxpayers
(Blumenthal et al. 2001a,b; Murphy & Byng 2002; Lederman 2003b; Raskolnikov 2008).
If we put aside the query over the proper weight to attach to various enforcement
considerations, simply incorporating non-monetary parameters and influencers into the
traditional economic analysis of tax compliance has often resulted in a better description
of real-world taxpaying behavior than a theory built only on selfish monetary assumptions (e.g. Allingham & Sandmo 1972 [incorporating reputation into their basic analysis]; Erard & Feinstein 1994 [adding guilt and shame]). To stay within the economic
paradigm, the rationality proposition no longer implies narrow materialism or pure selfinterest. Instead, rationality now reflects the reality that most people are constrained by
a wide range of considerations and that these considerations lead them to obey the law
when the sum of all potential costs of noncompliance, including likely moral, ethical, and
social sanctions, outweigh the expected gain.
A realistic and effective analysis of tax compliance must account for taxpayer motives
other than the desire to increase net income, eventually leading to a much needed
reassessment of the role that enforcement policy and mechanisms play in improving
compliance. Regulators and scholars in Australia have been involved in this particular
line of investigation during the past decade, with results that have important implications for tax enforcement in Australia, as well as in other industrialized countries and in
the broader, non-tax, regulatory sphere. The next section of this article will review the
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research into motivations and, particularly, those motivational influencers that have
been identified as commonly associated with taxpaying behavior. The article will then
introduce the concept of responsive regulation and explore the manner in which this
approach to regulation brings key elements of tax enforcement together to effectively
foster compliance.
3. The Australian approach to tax enforcement: Motivational postures,
taxpaying behavior, and service delivery
Innovative research in regulation has identified a group of motivational influencers –
best known today as ‘‘motivational postures’’ – that capture the way regulated entities
position and think about themselves in relation to the regulatory authority (Braithwaite
et al. 1994; Braithwaite 1995). In the context of compliance with tax law, motivational
postures describe how taxpayers see themselves as they relate to the tax system and its
administration and, particularly, the amount of social distance they wish to place
between themselves and those functions (Bogardus 1928; Braithwaite 2003b). This distance indicates the taxpayers’ degree of acceptance or rejection of the tax system and
authority, and, consequently, the extent to which taxpayers are open to their influence
(Braithwaite & Job 2003).
Strategies for inducing compliance are likely to vary in their effectiveness depending
on the motivational posture of the targeted taxpayers. Different regulatory and enforcement measures tend to be successful when dealing with taxpayers who see themselves as
law abiding citizens versus those who see themselves as opportunistic. Moreover, taxpayers who feel the tax authority insults them or treats them disrespectfully may respond
differently to enforcement than those who feel the tax authority approaches them with
integrity and respect (Wenzel 2007). For this reason, tax administrations that seek to
understand the taxpayers’ full range of motivational postures are likely to be better
situated to encourage taxpayers to ‘‘do the right thing’’ and comply with their tax
obligations while monitoring and constraining those motivations that might lead taxpayers down the path of noncompliance (ATO 1998, pp. 23 & 62).
Five key motivational postures have been identified as relevant to the realm of tax
compliance. These are: (i) commitment, (ii) capitulation, (iii) resistance, (iv) disengagement, and (v) game playing (ATO 1998, pp. 22–24; Braithwaite et al. 2001; Braithwaite &
Braithwaite 2001, pp. 410–411; Braithwaite 2003b, p. 18). The first two postures, commitment and capitulation, are compliant in nature, the former more than the latter. They
suggest the taxpayers’ cooperative interaction with and acceptance of the tax system and
its administration. The latter three postures, resistance, disengagement, and game playing, represent an increasingly defiant state of mind with the taxpayers’ growing distance
from and dislike toward the tax authority, system of taxation, and what taxpayers perceive they stand for.7
As Valerie Braithwaite explains, defiant taxpayers generally feel threatened by the tax
system and dissatisfied with democracy. These taxpayers tend to hold anti-government
and pro-market attitudes, have relatively weak identification with being a citizen and an
honest taxpayer, and support the abolition of the tax system (Braithwaite 2003b, p. 24).
Persuasion and punitive enforcement are less likely to affect defiant taxpayers, and they
are generally more invested in aggressive forms of tax planning (Braithwaite 2003b,
pp. 24 & 33).8 However, committed or capitulated taxpayers do not necessarily refrain
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from noncompliance. Behavior is the result of a variety of inputs, only some of which are
related to beliefs and attitudes, and so one cannot automatically assume a simple correlation exists between taxpayers’ mental states and behavior. Regulators must acknowledge this disparity between motivational postures and behavior and be responsive to
both to effectively manage compliance. Crucially, the tax administration does not only
serve as a passive observer of taxpayers’ attitudes and actions, but it also affects them
considerably.
In keeping with the influential work in compliance and procedural justice of Tom
Tyler, Allan Lind, and others, it is well understood today that taxpayers’ perceptions of
the procedural justice of the tax system – how the tax administration treats them and
other similarly situated taxpayers – affect the legitimacy that taxpayers attribute to the
administration (Tyler & McGraw 1986; Lind & Tyler 1988; Tyler 1990a, b). This sense of
legitimacy, in turn, affects taxpayers’ levels of compliance. Taxpayers who believe the tax
administration and its officials attempt to be fair and respectful toward them are more
likely to assign greater legitimacy to the tax system, align with its administration, and,
consequently, be more compliant with their tax obligations than those with more negative perceptions. Further, the tax administration’s positive behavior increases the likelihood of compliance because of people’s tendency to react in a like manner to behavior
they experience from others (Smith 1992). In accordance with this rule of reciprocity,
helpful and respectful service may also coax a broader normative commitment of compliance when taxpayers believe the administration acts positively toward them as a matter
of general practice (Smith 1992; Feld & Frey 2007).
The result of the taxpayer–tax authority interaction may be different, however, for
taxpayers who do not trust or respect the tax authority or for those who feel threatened
by it. When taxpayers feel uneasy with the tax authority, such as when they anticipate or
experience particularly unpleasant interactions, these taxpayers might adopt a coping
mechanism to protect themselves from the disapproval of tax officials (Braithwaite &
Job, 2003). This coping mechanism often boils down to an acute sense of taxpayer
polarization from the tax system and administration, sustained by feelings of alienation
and detachment (Braithwaite & Braithwaite 2001; Ahmed & Braithwaite 2005). Under
such circumstances, gaining compliance from taxpayers becomes extremely difficult.
When the tax administration employs punitive strategies that communicate disapproval,
the tension between taxpayers and the administration is likely to increase with the rise in
perceived disapproval, exacerbating any existing state of defiance. The challenge for tax
officials in these situations revolves around drawing out the more compliant stances
from taxpayers. Tax officials may be able do this by offering taxpayers cooperation,
positive and helpful service, and open dialogue as a first response to conflicts. With this
strategy, tax officials can address and diffuse toxic feelings, including antagonism, resentment, and distrust, enabling the administration to (re)connect with taxpayers on a positive level, and eventually elicit voluntary compliance (Tyler 1990b; cf. Smith 1992;
Braithwaite & Braithwaite 2001; Feld & Frey 2002; Frey & Feld 2002).
In cases where taxpayers do not meet the tax administration’s offer of cooperation
with compliance, the tax administration must be firm, but also fair, in bringing to
account those who do not comply. Whatever steps the tax administration takes must
not, as much as possible, adversely affect compliant taxpayers or escalate existing conflicts beyond what is necessary to gain compliance. In most cases, even when taxpayers
are resentful and angry, goodwill also exists and, with it, an opportunity to draw out the
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more cooperative postures and behaviors (Braithwaite 2003b). The key challenge for the
tax administration, therefore, is not so much to punish noncompliant taxpayers. The key
challenge is to interact with taxpayers in a manner that fosters goodwill and cooperation
so as to lessen the emergence of taxpayer defiance and aid in the management of those
conflicts that nonetheless arise (Braithwaite 1985; Murphy 2005b). The next section of
this article will draw on the Australian experience beginning in the late 1990s to suggest
that an effective approach to managing taxpayer compliance and achieving mutual
respect and cooperation includes a hierarchy of lesser sanctions and regulatory interventions, the possibility of severe and certain sanctions for noncompliance, and an
understanding of and responsiveness toward taxpayers’ motivational postures and their
compliance related behaviors and circumstances.
4. Responsive regulation and the Australian compliance pyramid
Until the mid-1990s, the regulatory style of the Australian Tax Office, like the regulatory
approach of most tax administrations in the industrial world, was authoritarian
(Braithwaite 2003a). This regulatory method, commonly referred to as ‘‘enforced compliance’’ or ‘‘command and control regulation,’’ developed out of the economics of
compliance paradigm. It called for the establishment of optimal, clear-cut rules for
taxpayers to follow and the forceful enforcement of these rules through threat of detection and legal punishment (Job & Honaker 2003). Despite its widespread dominance,
opponents of command and control often argued that this strategy misinterprets human
behavior and the meaning of noncompliance and that its one-solution-fits-all approach
is poorly suited for regulating compliance (Bardach & Kagan 1982; Ayres & Braithwaite
1992; Gunningham & Grabosky 1998; Sparrow 2000, Braithwaite 2002; Braithwaite
2007). The many complexities of the tax enforcement challenge suggest the need for
a comprehensive strategy that fosters long-term compliance. Yet ‘‘an approach which
relies heavily on detecting noncompliance and imposing sanctions on identified
offenders tends to be short-term in its effect and increasingly resource-intensive’’
(ATO 1998, p. 57). The Australian tax administration took to heart the criticisms of
the command and control method and, starting with the release of the 1998 Cash
Economy Task Force Report, embraced a new regulatory approach, one that moved
from authoritarian deterrence to a method of ‘‘responsive regulation.’’
In their 1992 book entitled Responsive Regulation: Transcending the Deregulation
Debate, Ian Ayres and John Braithwaite conceptualize responsive regulation as an
approach that does not necessarily result in any definitive program or a set of perceptions
prescribing a single best way to regulate. Instead, Ayres and Braithwaite envision responsive regulation as a method that advances the proposition that regulation should be
context dependent and yield different solutions depending on the regulatory circumstances
at hand (Ayres & Braithwaite 1992, p. 5). An administration that adopts responsive
regulation commits itself to investigating and taking into consideration the problems,
motivations, and circumstances of the regulated parties. It emphasizes dynamic operation,
assumes commitment to assisting the regulated actors in their compliance efforts, and
strives to enforce compliance across the board, even when the regulated are highly defiant
(Ayres & Braithwaite 1992, pp. 35–40 & 47–51).
Bringing together the idea of regulating responsively and the enforcement challenge,
Ayres and Braithwaite offer a holistic model for regulating compliance (Ayres &
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Braithwaite 1992). An expanded version of their model was endorsed in the 1998 report
of the Australian Cash Economy Tax Force (ATO 1998), after which the ATO adopted it
across the board for regulating tax compliance. The Australian compliance model is
represented by a pyramid with each of its three faces articulating one key aspect of
compliance, including: (i) the motivational postures taxpayers are most likely to hold
toward the tax system and its administration and display in their interactions; (ii) the
enforcement strategies at the tax administration’s disposal; and (iii) corresponding regulatory styles (ATO 1998, pp. 22–26). In this model, the motivational postures, regulatory measures, and enforcement strategies have a range of severity. The compliant
postures, cooperative enforcement strategies, and less intrusive regulatory styles are set
closer to the base of the pyramid. The areas higher on the model are reserved for defiant
taxpayers and harsher, more punitive and intrusive enforcement and regulatory practices
(Ayres & Braithwaite 1992, pp. 35–40; ATO 1998, pp. 24–26).
The tit for tat (TFT) methodology, a familiar practice in law and economics and the
game theory literature (Axelrod & Hamilton 1981; Axelrod 1984), was introduced into
the compliance model as the actual means for regulating responsively (Ayres &
Braithwaite 1992, pp. 19–53). In adopting the compliance model, with its TFT methodology, the ATO rejected the more traditional deterrence style of enforcement that is
grounded in a static calculation of the probability of compliance based on the expected
size and risk of punishment. Now, the ATO seeks to balance positive persuasion and
encouragement with punitive deterrence and incapacitation in a dynamic fashion. It
embraces the understanding that people care about different things in different contexts
and that they often possess multiple, even contradictory, selves: people can have a caring,
socially responsible self as well as an opportunistic self. Monetary considerations may
motivate individuals at one point and a sense of social responsibility at another
(Braithwaite et al. 1994; Braithwaite 1995). Accordingly, an enforcement strategy
grounded in punishment or persuasion alone is fundamentally deficient as it will either
undermine the good will of taxpayers or be exploited by their sense of greed. Both
persuasion and punishment have strengths and shortcomings in delivering compliance.
The key to successful regulation is not to decide between one approach or the other but
rather to establish a workable compromise between the two (Braithwaite 1985; Ayres &
Braithwaite 1992).
Embracing the TFT methodology, the ATO is required to balance encouragement
and persuasion with punitive deterrence through three stages of communication with
taxpayers: cooperation, toughness, and forgiveness. In doing so, the ATO draws on the
importance of procedural justice to effectively regulate compliance and the understanding that the tax office and taxpayers are partners in an ongoing relationship. Accordingly,
the tax administration will always start interacting with taxpayers at the bottom of the
compliance pyramid, soliciting cooperation through assistance, persuasion, and encouragement (ATO 1998, p. 30).
By reaching out to taxpayers, emphasizing education, good customer service, and an
open dialogue, the ATO targets taxpayers’ sense of social responsibility and bolsters the
prevention of noncompliance, while avoiding, at least early in the regulatory interaction,
the use of costly punitive measures that might undermine taxpayers’ goodwill and
intrinsic motivations to comply. If taxpayers choose to cooperate, tax officials must
proceed with cooperation. When taxpayers withold cooperation, the compliance pyramid instructs the tax administration to, gradually and proportionally, move to a higher
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level of enforcement and regulation (Ayres & Braithwaite 1992, p. 21). This incremental
escalation takes the cost of noncompliance up to the point where it becomes rational for
taxpayers to comply (Ayres & Braithwaite 1992, pp. 27 & 29–30). As soon as taxpayers
choose cooperation, TFT guides the tax administration to reward cooperative behavior
by moving down the pyramid, de-escalating enforcement and regulation (Ayres &
Braithwaite 1992, p. 21). However, for taxpayers who remain defiant, as well as for
the purpose of safeguarding a culture of obedience to the law, sanctions for persistent
acts of noncompliance must be severe and certain. To illustrate the importance of
balancing punitive enforcement with assistance and cooperation and the general workings and compliance effects of responsive regulation compared with a more traditional
authoritarian approach, the next section of this article will discuss the case of tax schemes
mass marketed to Australian taxpayers in the late 1990s.
5. The case of mass marketed tax scheme investors
In the late 1990s, the Australian tax administration identified a marked rise in the
number of taxpayers involved in tax schemes, particularly those related to tax deductions
(ATO 2000; Senate Economics References Committee 2000). Evidence revealed that the
amount claimed for scheme-induced tax deductions increased from about $A54 million
in 1993–94 to a striking $A1 billion or more in 1997–98. In 1998, as part of an institutionalized attack on aggressive tax planning, the ATO took action against 42,000 taxpayers suspected of investing in mass marketed tax deduction schemes (‘‘investors’’).
Implementing what seemed at the time to be a firm, no-nonsense approach to noncompliance, the ATO applied the anti-avoidance provisions of Part IVA of the Australian
Income Tax Assessment Act of 1936, legitimizing its power to amend the returns of the
investors to recover any tax shortfall, with interest and penalties, for up to six years after
the tax deductions were first claimed.
Instead of investors accepting the fact they were caught ‘‘with their hand in the cookie
jar,’’ and agreeing to comply with the amended returns to avoid further repercussions,
the direct authoritarian approach of the ATO produced reactance and resistance as
investors put up a fight. In the words of Kristina Murphy: ‘‘During much of 1998 and
1999 [.] thousands of investors made complaints to the Commonwealth Ombudsman
about the Tax Office’s handling of their case, various legal fighting funds were set up to
represent investors’ interests, and the majority of taxpayers involved simply refused to
pay back their scheme related tax debts’’ (Murphy 2005a, p. 3). In fact, four years after
the ATO mailed out the amended returns, more than 50% of investors remained noncompliant, despite the fact their debts were increasing significantly because of interest
and penalties.
In June 2000, the dispute between the tax scheme investors and the ATO transpired
into a full blown parliamentary inquiry (Senate Economics References Committee 2000,
2001, 2002). At this point, the ATO realized it needed a different approach to resolve this
conflict, and it established a direct, ongoing, communication channel with the investors.
The ATO also enlisted the assistance of researchers from the Australian National University and what has become the Centre for Tax System Integrity. The proceeding
communication and research efforts revealed, among others things, that despite the vast
variety of investors involved in the tax schemes (Braithwaite et al. 2007, p. 13), one
common denominator was the investors’ claim that what the ATO categorized as
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schemes were in fact investment plans sold to them by accountants and financial
planners as a way of legitimately minimizing their taxes. The investors resented the
ATO’s implication that they intentionally cheated on their taxes, and they were disappointed that the administration sent the amended assessments before giving them
a chance to explain their side of the story. These insights were instrumental not only
in explaining the high level of resistance this group of taxpayers displayed but also in
realizing the steps necessary to resolve the long-standing dispute.
In 2002, four years after the conflict between the ATO and the tax scheme investors
erupted, the ATO was able to effectively address the situation (ATO 2002; Senate Economics References Committee 2002). Based on extensive discussions and investigations,
the ATO finally acknowledged that many investors were victims of bad advice from
tax scheme promoters. Accordingly, the ATO gave eligible taxpayers the opportunity
to settle their debt while waving the original interest and penalties.9 Investors also
received a generous two-year interest free period in which to pay back the outstanding
amounts. At the same time, the ATO communicated that harsh consequences would
apply for persistent acts of noncompliance and that this offer represented a limited
window of opportunity to resolve the dispute. Investors initially received two months
to accept the settlement offer, later extended by three weeks.
The results of the 2002 settlement illustrate the advantage of a tailored and balanced
approach to regulating compliance over the more traditional authoritarian method, with
87% of all investors finally settling their debt (ATO 2002). By seeking to understand the
dispute with investors and the context in which it took place, and, consequently, engaging in more closely tailored sanctions and regulatory interventions, the ATO was able to
use its resources more efficiently to deal with the most defiant taxpayers who continued
to resist compliance. The ATO was also more apt to address the true source of the
conflict – the tax scheme promoters (ATO 2003). At the same time, tough enforcement
on noncompliers became more procedurally fair, defusing some of the resistance investors initially developed toward the tax administration and promoting better alignment and cooperation of taxpayers with the tax system and its administration (Murphy
2002, 2005a).10 Resolving the dispute with the investors also served as an opportunity for
the ATO to further entrench responsive regulation in its organizational culture. To take
advantage of this opportunity the ATO worked on changing the regulatory mindset
behind its enforcement measures. These changes included training tax agents and
administrators to ‘‘think responsively’’ such as by means of storytelling about regulatory
encounters with taxpayers and how these encounters played out instead of applying
narrowly defined rules and guidelines. Such changes also translated to ground level
developments of administrative practices, including various forms of auditing and
benchmarks, tailored to different industries and compliance circumstances (ATO
2003, 2007; cf. Job et al. 2007).11
Conclusion
Over the past several decades, research in tax administration has focused on examining
the causes and facilitators of taxpayer noncompliance. Experts have conducted these
investigations in the hopes of better understanding how to foster tax compliance and
minimize the tax gap. While the compliance research is far from conclusive, it does
support the economic model to the extent that taxpayers are generally sensitive to the
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expected payoffs of compliant and noncompliant behavior. Other things being equal,
taxpayers who face higher probabilities of detection or punishment tend to comply more
than those who face lower risks. Recent scholarship and regulation, however, increasingly
emphasize that compliance involves more than the probability and severity of punishment. Instead of abandoning enforcement policies based on detection and punishment,
this article embraces the understanding that these mechanisms should be balanced
against other measures that will complement punitive deterrence and offset its negative
repercussions. Tax administrators can achieve this balance by broadening the definition
of deterrence to include measures that curb illegal activity along with those that encourage legal behavior, such as by nurturing the social consciousness of taxpayers and furthering cooperation between them and the tax administration.
The Australian compliance model offers a viable framework that incorporates a balanced and broad approach in the enforcement of taxes. Drawing on the principles of
responsive regulation and the motivational posture doctrine, the Australian model conceptualizes taxpaying behavior as the result of factors that go beyond the needs, desires,
and constraints of the autonomous taxpayer. It also considers that environmental conditions, including norms, values, and social habits, as well as the nature of the taxpayer
interaction with the tax authority, are influential. Particularly, by focusing on the role the
taxpayer–tax authority relationship plays in tax compliance, the tax administration is
empowered to own up to its administrative responsibilities and explore different ways to
manage this relationship. The idea here is not only to enforce compliance in the face of
defiance but also to strengthen and manage compliance more fairly and efficiently to
improve voluntary reporting. This emphasis on voluntary compliance is especially
important in taxation given that the tax law is complex and constantly evolving. As
illustrated in the case of the mass marketed tax scheme investors, authoritarian enforcement alone might be politically undesirable and problematic to execute as well as counterproductive in its effect on compliance. Instead, enforcement policies might be more
effective when they start with self-regulation through encouragement and persuasion,
and only when necessary responsively move to punitive enforcement and intrusive
regulation.
With growing interest around the world in tax administration that focuses on customer service and embraces a dynamic approach to the enforcement of compliance, the
Australian model has the potential to generate different, possibly more effective, conclusions for tax enforcement than what we have seen thus far from the traditional
economic analysis of compliance. However, the Australian model, by relying on a method
that emphasizes the process of enforcement (‘‘managing relationships’’) rather than any
single defined regulatory or enforcement mechanism, presents challenges in its application. Considerable resources are needed to develop and test the effectiveness of various
regulatory and enforcement measures required in different regulatory contexts. It is
unclear, for example, which regulatory and enforcement tools best encourage voluntary
compliance at the bottom of the pyramid; how tax administrators can effectively present
the noncompliance repercussions to taxpayers in a way that encourages them to comply
early in the regulatory process; and which deterrent measures tax administrators can
carry out, and to what extent, without unnecessarily alienating taxpayers. Furthermore,
the heightened flexibility of the Australian model may become especially problematic if
tax administrators execute the model in ways that are inappropriate or otherwise unintended by the supporting enforcement policy. This risk is inherent in administrative
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practices generally, but the combination of an escalating range of enforcement and
regulation, the complex and fluid nature of motivational postures, and the extent of
discretion in a dynamic administrative style might increase the risk of enforcement that
is too lenient or too harsh compared with a more conventional approach.
In the end, the main advantage of the Australian model may be its ability to offer
regulators and researchers a broad, if incomplete, road map for enforcement that incorporates a set of checks and balances on punitive deterrence. More importantly, the
Australian model touches on critical issues in compliance and regulation that are well
deserving of policy attention and debate. The fact that this model does not come with
a self-explanatory guide may therefore constitute an important advantage. It forces tax
administrators and policymakers to debate and arrive at decisions that tailor solutions to
particular circumstances in a thoughtful and deliberate manner. As research into responsive regulation further evolves in taxation and additional compliance improvement data
and prototypes of the Australian model become available, we may continue to evaluate
the effect of regulating responsively on the integrity of the tax system and assess the
advantages and disadvantages of this method. In the meantime, we should pay close
attention to what may be the promising beginning of a new era of tax enforcement.
Acknowledgments
The author of this article is grateful for the generous support of the Internal Revenue
Service National Headquarters Office of Chief Counsel and Office of Research, Analysis,
and Statistics. Special thanks are owed to Chief Counsel Donald Korb, Associate Chief
Counsel Dennis Ferrara, Director of Research, Analysis, and Statistics Mark Mazur,
Director of Research Janice Hedemann, and Technical Advisor Alan Plumley. Special
thanks are also owed to the Bar Ilan University Law Faculty in Israel where the author
visited while finalizing this article and particularly to Tsilly Dagan who facilitated this
visit. Valuable comments and discussions on earlier drafts were offered by Reuven AviYonah, John Braithwaite, Kim Brooks, Janet Holtzblatt, Leandra Lederman, Kyle Logue,
James Sebastian, Joel Slemrod, Tom Tyler, David Levi-Faur, and three anonymous readers, as well as by the participants of the 2007–08 Tel Aviv University Faculty of Law Tax
Law and Policy Colloquium and the 2007–08 Interdisciplinary Center Law School
Faculty Workshop Series. An expanded version of this article appeared in the proceedings of the 2006 IRS Research Conference and is forthcoming in Michigan’s Journal of
Law Reform. Excellent editorial assistance was provided by Mary Dash and Marcie
Williams of the Internal Revenue Service Congressional Correspondence and Quality
Review Branch.
Notes
1
2
3
374
From tax year (TY) 2001 to 2005, the IRS reported an increase in enforcement revenue of
nearly 40% (IRS 2006, enforcement revenue table).
For example, according to IRS estimates, the US tax compliance rate currently stands at
83.7% (IRS 2006).
These findings, however, are not entirely conclusive. For a review of additional studies and
some contradictory results see Hessing et al. 1992.
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4
5
6
7
8
9
10
11
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See pp. 364–365 and 368–369 of this article.
Carroll (1989, p. 258) clarifies that this has been the case for efforts to regulate behavior in
diverse areas such as shoplifting, drunk driving, and family violence.
Smith (1992, p. 223) explains that deterrence based on the detection and punishment of
offenses is only one aspect of most enforcement and regulatory programs and that a mix of
strategies is generally common among regulatory agencies.
The research into motivation postures is still a work in progress. In New Zealand, for example,
the tax administration adopted a compliance model similar to the Australian one but featuring only four postures. Here, game playing was taken to be a subcategory within any of the
four other postures. See Morris & Lonsdale (2005, pp. 61–62).
Compared with Webley et al. (1991), finding that taxpayers who indicate alienation from or
negative attitudes toward the law and government are considerably more likely to engage in
evasion; Cowell (1990) reviewing the attitudinal and experimental literatures and finding that
attitudes and perceptions of the tax system are generally related to compliant and noncompliant behavior. See also Sheffrin and Triest (1992).
The ATO determined that a small number of investors who were promoters, tax agents, and
other tax advisers will be ineligible to accept the settlement offer because they should have
been aware of the true tax implications of their investments and will therefore face the full
consequences of their actions.
Murphy (2005a) analyzes longitudinal survey data collected in 2002 and 2004 to show that
investors who were more likely to think the 2002 settlement offer was fair (both in substance
and execution) were less likely to hold on to resistant views toward the ATO and more likely to
be compliant with their tax obligations in 2004.
Similarly, in the area of corporate taxation John Braithwaite (2005) illustrates how responsive
regulation may be particularly effective in increasing the compliance of large corporations
and, consequently, raising revenue. Braithwaite’s evaluation of utilizing the compliance model
to address illegal profit shifting by multinational corporations suggests that for every million
dollars invested in responsively regulating this area an additional billion dollars is collected.
Braithwaite also discusses how since the 1990s corporate tax collections generally in Australia
have grown three times faster than GDP growth when, in most other industrialized nations,
corporate tax collections decreased as a proportion of GDP (Braithwaite 2005, pp. 30 & 89–96).
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